Tuesday, February 14, 2017

Do oil prices influence wool prices?

Key points

Crude oil and polyester staple fibre prices tend to be strongly positively correlated, with period when the linkage breaks down.

Historically merino wool and crude oil prices have had little, if any, correlation however since 2008 the correlation has consistently been in positive territory.

The correlation of trade lamb prices with crude oil have also moved into positive territory since 2006.

The change to the lamb to oil correlation is a reminder that the change in the merino wool to oil correlation is not necessarily due to a development of a link between merino wool and oil prices.

A reader from South America has asked about the connection between crude oil and wool prices, if there is one. Crude oil is the source material for synthetic fibres which dominate the world fibres markets. This article takes a look at the correlation between oil, polyester staple and merino wool prices.

A rolling one year (12 month) correlation is used in this article to look at the correlation between wool and oil prices. A correlation of 1.0 would indicate prices move in lockstep, while a correlation of -1.0 would indicate prices are perfectly linked but move in opposite directions. A correlation of zero means there is no discernible connection between the price series.

By way of example Figure 1 looks at the correlation between 21 micron indicators in eastern Australia and South Africa (adjusted to US dollar terms) from 2000 onwards. A high positive correlation is expected between the two series, and this shows up in Figure 1 with the correlation occasionally dipping to zero or into negative territory.

Figure 2 looks at the correlation between crude oil and polyester staple prices from the late 1980s onwards. The correlation spends a lot of the time in the 0.6 to 1.0 range, meaning that often changes in polyester staple prices strongly reflect changes in crude oil prices. However there are periods when the correlation drops to zero or into negative territory, with the correlation negative for some 15% of the past 28 years.

In Figure 3 the correlation between crude oil and the average merino micron price is shown from the late 1980s onwards. The graph shows a quite volatile relationship between the wool and synthetic price, especially up to 2008. For this period there is no consistent correlation. From 2008 onwards the correlation has spent most of its time in the positive upper half of the graph, which implies a link between crude oil and wool prices.

Figure 4 shows the rolling correlation between a NSW trade lamb price series and crude oil from the late 1980s. While varying regularly it spent the time before 2002 generally in negative territory and since 2002 mainly in positive territory. The old saying “that correlation does not mean causation” is useful to recall every time correlations are considered. While the move of the correlation into positive territory for wool and crude oil price correlations since 2008 implies a connection, a similar move by the lamb and oil correlation in Figure 2 suggests the correlations are happening for reasons other than direct or well defined indirect links.

Logic suggests that crude oil through synthetic fibre prices such as polyester staple and acrylic will have an impact on other fibre prices, such as cotton and wool. The concern which the cotton industry regularly has about low polyester staple prices fits with this logic. The evidence shown above however demonstrates that these effects are inconsistent at best, which reflects the complexity of influences on apparel fibre prices.

What does this mean?

Crude oil prices are an important factor in the global economy. Significant moves in oil prices can impact on merino wool prices, through changes to economic growth. This is a very indirect link. The variation in short term correlations of oil and merino wool prices shows that there is no consistent direct link, within the apparel fibre markets. Oil prices can be an influence on wool prices but needs to be considered on a case by case basis.

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